Economics

Central bank independence and public debt policy

Article Abstract:

A policy game model with elements from Alesina and Tabellini's (1987) model, explains the institutional design of the European Monetary Union (EMU) in terms of monetary and public debt policies. The model shows that coordinated policies by policy-makers can restrain debt accumulation, while asset accumulation replaces commitment to restrictive monetary policies. It also shows the need to supplement monetary institutions of myopic governments with public debt target to prevent a conservative central bank from excessive debt accumulation.

H. Jensen's loss of monetary discretion model was extended to show that a zero-inflation rule may be much favorable compared to monetary discretion if real base money holdings are relatively low, which is expected in modern economics. There is a greater possibility that the zero-inflation rule will be favored if the emphasis on achieving public spending and output goals is reduced. Thus, the recent increase in the support for binding policy rules is in accordance with the reduced tolerance to inflation.